Advances in Economics, Business and Management Research, volume 211

Proceedings of the 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022)

Application and Comparison of NPV and IRR Methods

in the Company Investment Decision
Jinqiao Huang 1, † Jianwen Tong 2, † Peini Wang 3, *, † Xilin Zheng 4, †
1
School of Finance, Nankai University, Tianjin, 300350, China
2
School of Business, East China University of Science and Technology, Shanghai, 201424, China
3
School of Social Science, the University of Manchester, Manchester, M13 9PL, UK
4
School of Business and Tourism Management, Yunnan University, Kunming, 650000, China
*Corresponding author. Email: peini.wang@student.manchester.ac.uk
†
Those authors contributed equally.

ABSTRACT
In order to find out the application conditions of Net Present Value (NPV) and Internal Rate of Return (IRR) in
practice, based on previous studies, the paper summarized the advantages and disadvantages of the two methods and
explores the specific application conditions in corporate finance. The results showed that the NPV method can reflect
the liquidity and overall profitability of investment, provide clear expectations, and be more comprehensive in risk
measurement. However, the NPV method could not avoid the problem of cash flow uncertainty. Moreover, the
opportunity cost is limited by the project and corporate transparency. It was also found that the IRR method can easily
calculate the rate of return on investment and compare it with the industry benchmark return on investment, which has
been widely used by practitioners. However, the IRR method may produce multiple values when the cash flow is not a
fixed annuity, and the IRR is a ratio that cannot reflect the actual profit. Therefore, several modified NPV and IRR
methods were introduced and discussed with their application conditions. In practice, to be noted, there may be
inconsistencies between NPV and IRR for investment evaluation. Although both NPV and IRR are effective methods
for company investment decisions, it is suggested that, the investment situations should firstly be analyzed before
making decision of which methods to be chosen.

Keywords: Net Present Value, Internal Rate of Return, Advantages, Disadvantages, Company Investment
Decision

1. INTRODUCTION
In the field of company investment, most projects
are characterized by long-term and large capital
expenditure. In order to reduce projects’ investment risk
and make correct decision for enterprises, it is necessary
to there are some investment decision-making methods,
such as Net Present Value (NPV) [1], Internal Rate of
Return (IRR) [2], Payback Period (PBP) [3] and so on.
Among them, the NPV and IRR methods have been
widely utilized in companies' investment
decision-making. Recent evidence shows that a number
of corporations in the United States and the United
Kingdom use IRR more frequently for assessing capital
projects, while companies in India and South Africa are
increasing their use of NPV [4]. The phenomenon above
shows that both ways are extensively recognized as
useful and practical methods.
There are many scholars who have used NPV and
IRR methods to help companies choose the most
feasible project. In the project of oil and gas exploration,
Salam et al. used NPV method to demonstrate that the
cluster developments could create larger economic
benefits [5]. Besides, Diatin et al. successfully selected
the project with the poorest financial performance from
all the three projects in the catfish farming industry
through NPV and IRR methods [6]. Moreover, these
two approaches have also been frequently utilized in
projects’ economic feasibility studies. For example, the
application of NPV in the photovoltaic energy storage
project proved the economic feasibility of grid parity,
and also helped enterprises find the boundary conditions
for achieving grid parity within the economically
feasible range [7]. There is considerable evidence that
the majority of companies choose NPV and IRR to
assess the economic feasibility of metal mine projects,

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 Advances in Economics, Business and Management Research, volume 211
although these two ways ignore the impact of the
interaction of uncertainties on the calculation results [8].
Some scholars have also noticed the inconsistency
between NPV and IRR methods in the application. The
study of Magni and Marchioni suggested that IRR is
weakly consistent with NPV [9]. Banerjee found that,
when facing two mutually exclusive projects that
require different amounts of investment each year, the
director of the oil refinery company would obtain
contradictory results using NPV and IRR methods [10].
Chen also mentioned that non-conventional projects,
such as real estate projects, mineral resources
development projects, and some repeatedly investing
projects, would lead to decision-making mistakes when
applying the traditional IRR rules [11].
Considering the contradictory results by the above
two methods, the modified NPV and IRR methods were
proposed and applied gradually. Fuzzy Net Present
Value [12] was used as a fundamental by Zhang et al. to
propose a new evaluation method for a single
investment project [13]. Likewise, taking advantage of
Decoupled Net Present Value [14] to separate the time
value and risk cost, Dou et al. believed that it was more
helpful to analyze the economic feasible factors of deep
mineral resource exploit projects [15]. Furthermore,
Johnston et al. considered that the additional
information about the expected finance rate and
expected rate of return would be provided by the use of
Modified Internal Rate of Return [16,17] in the
assessment of the pearl production project [18].
Similarly, Cuthbert and Magni chose the Average
Internal Rate of Return [19] to measure performance in
Private Finance Initiative schemes [20].
Therefore, this paper aims to clarify the latest
application progress of NPV and IRR methods in the
company investment decision, and the existing
shortcomings and modified versions of the above two
methods are also analyzed to provide references for
future study.
The remainder of the paper is organized as follows.
Section 2 discusses the recent literature on the NPV and
IRR while Section 3 presents the application of them
and then provides conclusions.
2. LITERATURE REVIEW
2.1. Background of NPV and IRR methods
The concept of Net Present Value was first put
forward by Irving Fisher in ‘The Interest of Rate’.
According to Irving Fisher, NPV is the difference
between the present value of future inflows of funds and
the present value of future outflows of funds, which is
the basic indicator of the NPV method in project
appraisal [1]. The study by Ross suggests that the NPV
rules could easily reject a project by considering the
factors of capital market alternatives [21]. A noticeable
point is that to determine the net present value, future
inflows and outflows of funds should be converted to
present value by the discount factor of each period. This
expected discount rate is determined by the lowest rate
of return on investment for the enterprise, which is the
minimum acceptable boundary for an enterprise's
investment. However, it is undeniable that the NPV rule
does have some drawbacks which will be discussed later.
In addition, IRR method used to evaluate investment
decisions will be presented in this paper. IRR is the
discount rate at which the total present value of inflows
equals the total present value of outflows and the net
present value equals zero. In short, IRR is the rate at
which the project breaks even [22]. It is the rate of
return that an investment aspires to achieve, and the
larger the indicator, the better. In general, if the IRR is
greater than or equal to the base rate of return, the
project is viable. Kelleher and MacCormack provide
more detailed information that three-quarters of CFOs
prefer using IRR rules to evaluate capital projects [23].
In the following, we will analyze and present the
advantages and disadvantages of using IRR and NPV in
detail.
2.2. Advantages and disadvantages of NPV and
IRR methods
2.2.1. Advantages of NPV
Many studies have described some benefits of the
NPV approach, and this paper will mainly introduce the
following four advantages. This includes time value of
money, cash flow forecasting logic, investment decision
making simplicity, and risk assessment.
In Gollier and Weitzman’s study, one of the benefits
of NPV is that it employs discounting as a basic notion,
allowing impacts to be compared at multiple future
dates by converting each future dollar into equivalent
present currency [24]. According to Watson, net present
value considers one project’s all cash flows and net
revenue throughout the course of a project's life cycle,
demonstrating the investment's liquidity and overall
profitability [25]. Besides, the NPV method assists
investors in making obvious investment choices through
a simple formula, suggested by Gaille [25]. Although
there is no assurance that an investment will yield the
expected return, the information given by this method
may be used with to give a pretty clear picture about
whether this project can bring value to investors [26].
Furthermore, in the study of Prachi M, systematic risk
and industry risk are taken into account via a
sophisticated selection and modification of discount rate,
making the method more comprehensive in risk
measurement [27].
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2.2.2. Disadvantages of NPV
In practice, investors find the NPV method
challenging to use and therefore do not utilize it as their
primary decision-making tool. The unpredictability of
cash flow, the sensitivity of the discount rate, the
problem of discount rate selection, and the static
character of investment decision-making are the major
topics of this part.
Because there is no guarantee that the cash flow
estimation is completely accurate, the NPV method will
always suffer from cash flow uncertainty, rendering the
information about determination provided by NPV
useless. For example, the study of Beladi et al. showed
that great cash flow unpredictability makes businesses
less willing to put money into R&D innovation even if
the NPV is high [28]. Besides, as Weber’s paper shows,
the discount rate has better exposure to NPV, thus if a
tiny perturbation is introduced to the hurdle rate, the
changes are usually unpredictable [29]. Moreover, since
the size of the discount rate will directly affect the
priority of alternative items, different discount rates
chosen for various objectives will do have their own
adverse impacts on NPV calculation [30]. For example,
according to Emhjellen and Alaouze, using the Weighted
Average Cost of Capital (WACC) as the discount rate is
Table 1. Studies on the advantages and disadvantages of NPV
Advantage Author(s)
 The application of Christian Gollier &
discounting as a basic Martin L.Weitzman
notion.
 Demonstration of the Kevin Watson
project’s liquidity and
overall profitability.
 Easy determination Louise Gaille
 System risk and Prachi M
industry risk are taken
into account.
2.2.3. Modified methods of NPV
The development of NPV has also been a constant
process of refinement and revision. As a result, a
number of more sophisticated NPV correction methods
have been derived.
Cardwell has mentioned a method named decoupled
net present value (DNPV) which separates the time value
willing to result in the overvaluation of the portfolio
[30]. Meanwhile, using opportunity cost is limited by
the projects and information we encounter. Finally,
according to Costanza etal, discount rate, which is
considered to be one basic conception, should not be
constant but rather decrease with time [31]. Since the
NPV conclusion is static to represent the point of time,
this method leads to a calculation dilemma, whose result
at present will also fail to accurately reflect future
circumstances [31].
It’s believed that the factor of discount rate has the
greatest impact on the application of the NPV method.
The most difficult obstacle is determining what
reference data or accounting methods are used, how to
make subsequent adjustments, and how to reduce the
difficulty of calculation under rapidly changing market
conditions. There is no agreed standard being proposed
to select and adjust discount rates, and no strategies for
decreasing calculating complexity have been suggested,
thus more research is needed.
For the eight papers studied above, this part
categorized them in the sheet below (TABLE I). In the
categorization process, TABLE I included several
aspects of Advantage, Disadvantage and their respective
Author(s).
Disadvantage Author(s)
 Suffering from cash Hamid Beladi, Jie
flow uncertainty Deng& May Hu
 Unpredictable Thomas A.Weber
changes in NPV due
to the hurdle rate
 Different types of Magne Emhjellen
discount rates have &Chris M.Alaouze
adverse impacts on
NPV calculation.
 The discount rate is Robert Costanza,
actually decreasing Ida Kubiszewski,
with time rather than Natalie Stoeckl
stable. &TomKompas
of money from the risk associated with projects [32].
DNPV method enables investors to price the risk related to
the value of the product developed and/or the investment
required to create the asset by combining heuristic
(experience-based) procedures with an advanced
probabilistic and stochastic techniques [32]. In other words,
DNPV gets more reliable decision-making by separating
the two separate variables which are time and risk, rather
than directly equating the time value of money with risk.
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The risk of an investment is inherently uncertain, but
the NPV approach quantifies it directly as a specific
fixed value, which may lead to biased decisions.
According to Sanches, Pamplona, and Montevechi,
fuzzy NPV avoids and deals with this problem very well
by introducing fuzzy theory. Fuzzy NPV treats uncertain
risk as a fuzzy variable rather than recognizing it as a
specific value, thus creating a decision model based on
fuzzy theory. Therefore, by taking into account the
uncertainty of the risk variables, fuzzy NPV will lead to
more accurate and comprehensive conclusions [33].
2.2.4. Advantages of IRR
For research on the optimal investment decisions,
the IRR is a handy and useful method for calculating the
economic rate of return on invested capital, which has
been researched since Keynesian firstly put forward the
concept ‘marginal efficiency of capital’ [34]. From then
on, with the widespread use of IRR, many practitioners
and decision-makers have become proficient in applying
IRR and formed mature experience in operation.
The study by Duncan suggests that the advantages of
IRR as an alternative can be seen easier in light of the
NPV measure. Focused on the definition, the article
illuminates that IRR is a strictly definable term, which
can only be applied to evaluate the desirability of
projects. Since it reflects the profitability of the project
itself, it’s easy for the management to make the profit
maximization, i.e., to choose the highest IRR which is
greater than the hurdle rate. As Duncan says, they often
compare IRR with the hurdle rate, indicating IRR is the
upper limit on the interest rate that could be paid to
repay the loan and still make a profit. The form of ratio
also facilitates the comparison among the projects with
different investment scales [35].
Besides, Babaei and Bamdad draw attention to the
fact that there is no need to consider the financing
problem when adopting IRR [36]. Unlike other
evaluation indices, the calculation of IRR avoids the use
of uncertain conditions of the interest rates, making it
easier to get results. It is noticeable that the IRR method
takes all the cash flows contained in different periods
into account as well, according to Weber [37].
Table 2. Studies on the advantages and disadvantages of IRR
Advantage Author(s)
 Straightforward to use: Duncan A.
the highest IRR which is Mellichamp
greater than the hurdle
rate
 The form of ratio Duncan A.
facilitates the comparison Mellichamp
among projects.
2.2.5. Disadvantages of IRR
Nevertheless, since many economists and engineers
have taken the IRR method, they have found its pitfalls
in the decision-making process, thus it is important to
consider these special circumstances simultaneously
when evaluating the desirability of investment projects.
There have been many studies on the shortcomings of
the IRR as follows.
First, as Cuthbert and Magni's paper shows, the use
of IRR has strict preconditions that the relevant payment
streams must be the type of flat and annuity ones [20].
When the net cash flows are not in pattern (i.e.,
unconventional cash flows), which is similar to the
definition of 'fuzzy cash flow' promoted by Biacino and
Simonelli, there will be more than one or no results of
IRR, which has no economic meanings at this time [38].
A noticeable point is that an underlying assumption
is implied in IRR. The paper by Weber reveals that the
cash inflow generated by the project and the rate of
return produced by reinvestment are the same as IRR,
which might not be applied to all practical situations
[37].
Moreover, as is described in a specific investment
case by Jiang, IRR can’t show clearly that how many
profits the company will gain by investing in this project
because it is a non-dimensional rather than a scaled
quantity, which is misleading [39]. To be more specific,
if the capital cost is smaller than the crossover rate of
return, the project with a low IRR has a higher net
present value.
Unlike other articles, the study conducted by
Xepapadeas looks from a broader angle rather than
small details. It puts forward that when capital inputs are
optimally adjusted in a competitive economy in
long-run equilibrium if long-run equilibrium does not
prevail, the IRR can be regarded only as an
approximation of the true economic return that is
generated by capital inputs [40].
For the seven papers studied above, the Advantage,
Disadvantage and their respective Author(s) are
categorized in the sheet below (TABLE II).
Disadvantage Author(s)
 Strict precondition James R.
of payment stream: Cuthbert&Carlo Alberto
a flat, annuity Magni's
 The impractical Thomas A. Weber
assumption
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 No need to consider the Golnoosh
uncertain interest rate Babaei, Shahrooz
Bamdad,A
 All the cash flows Thomas A.
contained in different Weber
periods are considered.
2.2.6. Modified methods of IRR
In view of the existing drawbacks that IRR has
above, many scholars have been dedicated to finding
measures to modify the disadvantages of the traditional
IRR. In fact, two methods have been recognized by
academia, which is Modified Internal Rate of Return
(MIRR) and Average Internal Rate of Return (AIRR).
According to Kierulff, under the circumstance of
unconventional cash flows, adopting the MIRR method
can not only avoid the situation of no or multiple
solutions but also simplify the calculation process [41].
It also corrects the unreasonable assumption, replacing
IRR with WACC as the reinvestment rate.
In addition, as Hazen and Magnithe pointed, the
AIRR fixes many pitfalls related to the traditional IRR.
When analyzing the projects with different levels of risk,
AIRR forms a scale-efficiency decomposition of NPV,
uniquely breaking down a risky NPV into a
risk-sensitive project scale and extended AIRR. This
shows the risky levels of investment projects, which is
an intractable problem for IRR [42].
3. APPLICATION OF NPV AND IRR
3.1. Application of NPV
When NPV is greater than or equal to 0, the project
is adopted. If NPV is less than 0, the item is discarded.
And comparing multiple mutually exclusive items, we
usually choose the item with the largest NPV. Professor
Zhang of Nanhua University applies the NPV method to
the economic analysis of uranium mining projects [43].
He finds that two problems need to be solved when
using the NPV method for investment decision-making
of uranium mining projects. One is to predict the future
cash flow of the project, and the other is to estimate the
discount rate. The final NPV value is about 660,000,
which is far greater than zero, so it is worth investing.
Finally, the fact that the uranium mine brings huge
economic benefits proves the correctness of Zhang's
analysis. It can be seen that the NPV method is perfect
in theory, simple and direct. It can judge whether the
investment can be made only by calculating the net
present value of the project. Therefore, the NPV method
has been widely used to make the investment decision
of industrial projects.
 No exact number of Huanping Jiang
profits is gained.
 The condition of Xepapadeas, A.P.
long-run equilibrium
is needed.
Besides, we should also consider the application of
additivity. Additivity means that if two items are
independent of each other, their NPVs can be added.
(Ross 2003 Corporate Finance) This feature has many
valuable meanings which can make the NPV method
convenient in application. For example, the relevant cost
of a project is not considered in the calculation due to
negligence and other reasons. In the calculation, the cost
can be discounted and subtracted from the original NPV
without adjusting other projects [44].
3.2. Application of modified NPV
Zhang and Xiao studied the problem of project value
evaluation and portfolio selection under the assumption
that the project investment capital and net cash flow are
fuzzy variables [23]. They use FNPV to examine the
profitability of an annuity investment project during its
calculation period. According to the financial net cash
flow of each year in the project calculation period, they
get the appropriate value to select the comprehensive
risk-return index of the optimal investment strategy.
At the same time, DNPV is also an effective
modified NPV model. Dou and Pan analyzed the
profitability of deep mineral resources development
projects using DNPV method [25]. The researcher
analyzed a manganese mining project located in
Guizhou Province, China, selected several main risks
affecting the expected income, and analyzed the
feasibility of the project based on DNPV technology.
Traditional economic evaluation methods are difficult to
accurately identify and evaluate risks, but DNPV
provides an effective tool to separate time value and risk
cost, which is helpful to find the real value of the
project.
3.3. Application of IRR
Based on the application of NPV, when IRR is
greater than or equal to the discount rate of the project,
the project is adopted. When IRR is less than the
discount rate of the project, the project is abandoned.
When comparing multiple equal items, we usually adopt
the item with the largest IRR. Zou of Fudan University
used the IRR method to analyze the investment of a road
and bridge construction enterprise in the case of
financial leasing and purchase of construction
equipment [45]. After calculation, it turned out that
when the yield was 10%, the IRR value was 13.25%,
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indicating that the project is feasible. By observing the
internal rate of return index, the financing company can
not only see the income of the project but also observe
the relationship between the project rate of return and
capital cost after the change of capital cost. Therefore,
the product attributes of financial leasing companies
determine that it is practical to use indicators to make
project income decisions.
We should also pay attention to the application of
multiple unequal investment projects. Judging the
advantages and disadvantages of an investment project
depends on the situation. If the investment decision is
judged only according to the investment efficiency of
the project, the internal rate of return is the most suitable
method for investment evaluation [46].
3.4. Application of modified IRR
In the paper of Kierulff, the MIRR method adopts
different discount rates to calculate IRR, taking the cost
of capital into account in the cash expenditure
calculation. The average rate of return on reinvestment
is considered in the calculation of income at the same
time [41]. During the process of the decision-making
with venture capital investments, the MIRR is applied to
analyze whether the project is feasible through the
comparison with the capital cost.
In practical applications, especially for projects with
long-life cycles and uncertain fluctuation in the future
markets, the MIRR is more associated with the market
situation. The study by Johnston and his fellows takes
the approach to evaluate the profitability of cultured
pearl production [18]. However, the MIRR has
deficiencies in relative independence and objectivity
because of the dependence on the enterprise capital cost,
which may cause disputes.
On the other hand, the AIRR method is the ratio of
total profit to total investment, and it is also the capital
weighted average of return on investment at the same
time. This measure can be applied in both industrial
projects and financial programs. In the study conducted
by Cuthbert and Magni, the measure is taken to assess
three PFI medical projects and compared with IRR to
illustrate the danger in applying IRR as an index to
evaluate the performance of financial projects [20].
3.5. Inconsistencies between NPV and IRR in
practice
In practice, there may be inconsistencies between
NPV and IRR. When using IRR rules and NPV rules in
different situations, there may be different solutions.
Firstly, multiple internal rates of return may occur when
the cash flows are unconventional. For instance, there
may be several IRRs when the cash flows change
positively or negatively more than once [47]. The
noticeable point is that multiple internal rates of return
may produce a different result from the NPV calculation.
When multiple IRRs appear, they should be considered
in combination with NPV. A single IRR solution is not
appropriate. Additionally, when two projects are
mutually exclusive projects, inconsistencies between
NPV and IRR solutions are also possible. Mutually
exclusive projects are alternative projects that cannot be
run simultaneously. When we make decisions, the NPV
method is used to select the project with the highest
NPV greater than 0 and the largest, and the IRR method
is used to select the project with the highest IRR that is
greater than the required rate of return. However, the
two methods may give different results when the two
projects are mutually exclusive. In such instances, when
deciding between mutually exclusive projects, the
decision-makers should choose the one with the highest
positive net present value based on the appropriate cost
of capital. The reason for this is that a company's goal is
to maximize shareholder value, and the project with the
highest NPV has the greatest impact on stock prices [48].
Managers should not only focus on the rate of return but
more on the real return obtained. In this case, NPV is
always the superior method. Because compared to the
IRR rule, the NPV rule gives more logical and reliable
solutions.
4. CONCLUSION
This paper reviews the advantages and
disadvantages of NPV and IRR as well as their modified
versions and applications based on forty-seven relevant
papers. It is found that NPV and IRR methods may yield
different decision results, and possible reasons of these
findings are collated and discussed in detail in this paper.
Additionally, the results of this paper can provide
metrics for decision-makers who actually use NPV, IRR,
or their modified versions to achieve optimal decisions
in practice. The correct choice and application of NPV,
IRR, as well as modified NPV and IRR will directly
contribute to the company's ability to maximize profit.
Therefore, this paper could provide good references for
those who do research on investments in financial
markets and company decision-making methods.
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